A punishment, not a solution
It is now official: Cyprus will pay a heavy toll for turning its economy into an offshore financial haven and allowing its banking sector to hyperinflate. But if the purpose of the dramatic eurozone all-nighters was not just to punish and make an example of the island, but to solve the issue, then we can hardly speak of a success.
Despite the fact that the Eurogroup agreement on March 25 prevented an immediate and disorderly bankruptcy, there is no doubt that the coming months are going to be dramatic for Cypriots. Indeed, European Commission Vice President Olli Rehn even likened the situation faced by the Cyprus population to the Turkish invasion of 1974.
The agreement provided for the resolution of the country’s second-largest lender, Cyprus Popular Bank (Laiki). Beyond the fact that such a development will lead to job losses, it also means that all deposits of natural or legal entities exceeding 100,000 euros will virtually be wiped out. Maybe it will take years before the clearance procedure is complete and depositors receive some kind of compensation, which in any case would be much smaller than the sums lost due to the haircut.
Bank of Cyprus clients with deposits over 100,000 euros will also suffer heavy losses. In fact, the decision provides that uninsured deposits in the country’s largest bank will remain frozen until the precise size of the haircut is decided in order for the bank to achieve a capital ratio of 9 percent. Hence, hundreds of domestic companies have had their cash reserves depleted and their current accounts obliterated. Some – if not most – of them will go bankrupt in the coming days and weeks. These developments, in combination with the imposition of restrictions on the free movement of capital – also for an unspecified time period – raise serious doubts as to when the island economy will be able to function properly again.
The destruction of capital – unprecedented in scale – the loss of confidence in the banking system, which had served as a basic pillar of the island’s economy as well as a jobs pool, the inevitable outflow of deposits and the general uncertainty are expected to deepen the recession in Cyprus beyond even the most pessimistic forecasts. In this sense, the sustainability projections of the draft memorandum of understanding between the troika of international lenders and the government in Nicosia should be considered as already obsolete, and the assistance program is already way off track. But given that the eurozone is not willing to provide funding beyond 10 billion euros, the big question that now arises is how the inevitable funding gap between solvency and insolvency is going to be covered at a time when the economy is sinking and unemployment is spiraling out of control. Whether BoC will survive is equally uncertain, since besides the deposit outflows it will suffer, it has also been forced to assume Laiki’s obligations to the European Central Bank, which amount to 9 billion euros (around 50 percent of Cyprus’s gross domestic product).
Moreover, the unfortunate handling of the situation by the Eurogroup and the Cypriot government over the last few days has shaken the trust of Cypriot citizens in the country’s European trajectory, as recent polls have shown. Equally fragile is the confidence of citizens and markets in the eurozone’s crisis management skills. If the – undoubtedly substantial – difficulties of a small economy like Cyprus are able to cause so much trouble, what then should be expected if a major crisis occurs in Italy or Spain? In fact, the Eurogroup’s initial decision to impose a levy on deposits below 100,000 euros makes it clear that in case of a major crisis in the future, the eurozone is ready to “cross the Rubicon.” In an interview with the Financial Times, Eurogroup chief Jeroen Dijsselbloem went as far as to imply that the Cyprus model will be used as a template for the rest of the eurozone and that depositors with more than 100,000 euros in their accounts may be requested to foot the bill for failed banks in the future. His message was clear: “Take your money and run from the South.” Such statements make one wonder if the person running the eurozone wants to preserve it or single-handedly destroy it.
Could things have taken a different turn? Of course they could, if the necessary political will had been there. Although Berlin was right to point out that the Cypriot economic model, which was based on the financial bubble, was not sustainable, the dissolution of this model in the timespan of just a few days, instead of a few years, is bound to cause more problems than it will solve, given that no alternative plan has been designed, let alone implemented, yet.
And yes, Cyprus made many mistakes and the punishment may indeed be commensurate to the “crime” committed. But what about the mistakes of the eurozone leaders? Their response to the crisis so far has been ridiculously unsuccessful, no matter how one defines success. The continent’s economy is going through a double-dip recession. Even Germany, the supposed paragon of economic performance, is stagnating, unemployment is surging to all-time highs, the eurozone GDP is much lower than its pre-crisis levels, and the banks of the Europe are walking dead, unable to provide credit to the economy. Populist, secessionist and nationalist movements are on the rise across the continent, ghosts of the past have been awakened and the European unification project is at stake. Countless late-night meetings failed to restore confidence, and some of them, like last week’s decision to disrespect the sanctity of retail deposits, were downright catastrophic. Whether Cyprus deserves its fate or not, the inescapable truth is that the major flaw in the eurozone’s crisis management system is that people are not laid off when they mess up. And that’s why they keep messing up.
* Nikos Chrysoloras is a Brussels-based EU correspondent for the Greek and Cypriot daily Kathimerini. An earlier version of this article was published by the Crisis Observatory (crisisobs.gr) of the Hellenic Foundation for European and Foreign Policy (ELIAMEP).
